Six months ago we wrote a piece questioning whether we were in a booming economy (Technical Scoop - The booming economy? - September 18, 2004). Today of course we can't help but notice that since then the stock market is up about 5% for the Dow Jones Industrials, 7% for the S&P 500, just under 8% for the NASDAQ and the real star the S&P/TSX Composite is up about 15% led by energy, metals and gold. A strong economy or the belief that the economy is going to improve is one of the prime reasons that the stock market rises. So does that mean that we are off and that the stock market is now headed for the highs of 2000 on the back of a rising economy? Especially when it was only in our last article that we wondered "Is America broke?"
This month is also the 5th anniversary of the all time stock market highs. So if the measure of a booming economy is the heights of the stock market then it is clear that while we are certainly well up from where we were in October 2002 (the lows) but the highs of five years ago remain elusive. Indeed we are reminded that anniversary dates are very important and seeing that once again we are at highs on these important anniversary dates is not exactly a warm fuzzy feeling we get as they are often important turning points.
The Dow Jones Industrials topped first on January 14, 2000 at 11723 (close). The NASDAQ followed on March 10, 2000 topping at 5049; the S&P 500 topped on March 24, 2000 at 1527 and finally the S&P/TSX Composite topped last six months later on September 5, 2000 at 11,328. Today the DJI remains about 1000 points below its all time high close or about 8%, the S&P 500 is down over 300 points or about 21%, the S&P/TSX Composite is off over 1600 points or about 14.5% while the NASDAQ is the hardest hit down almost 3000 points or about 59%. Some boom.
Of course as always, is the glass half full or half empty or as I am sure the bull optimists might view - don't look how far we have fallen but look at how far we have come. If your perspective is from the depths of the October 2002 lows then things are indeed looking up. The DJI is up almost 44%, the S&P 500 up 50%, the S&P/TSX Composite up a huge 70% and the NASDAQ up even more at 84%. Times are great. Let the good times roll. So which is it boom or bust?
We have always contended that we are in secular bear market but experiencing a cyclical bull market. And these cyclical bulls (or B waves as Elliott Wave Theory would call) within the context of a secular bear can be very tricky. The hardest hit in the bear market was the big winners of the late 1990's, the high tech sector. Numerous high tech flyers are today trading at a fraction of their value in 2000. Witness Nortel who topped in late July 2000 near $123 and today sits at $3.64 (note: which is well off its low close of $0.69 in October 2002). In between the tech wreck left thousands of investors a lot poorer, cost ten's of thousands their jobs and resulted in numerous scandals and bankruptcies. Today the high tech industry while somewhat recovered still sits with huge overcapacity and will take years to recover even a modicum of its former glory. The companies that have survived are probably a lot a stronger for the experience but they themselves may never recover to those former highs in most people's lifetime.
The market of the late 1990's was pushed along on a sea of liquidity as the Federal Reserve flooded the system with money related first to the US$ currency and bond crisis of 1994, pushed further by the Asian flu of 1997 and then the Russian crisis and more Asian flu in 1998 and finally the looming Y2K crisis of 2000. Indeed not only did the Federal Reserve help flood the system with funds but all Central Banks globally were guilty. But since Central Banks don't actually print money it takes a huge loosening of the private banking system to really unlock the funds to provide the liquidity. Reserve requirements also ended by the mid 1990's and this as much as anything helped unleash the fuel for the bull market at the end of the century.
Only when the Fed was forced to raise interest rates in 2000 and take some of the steam out of the bubble market and soak up some of the excess liquidity did it unleash the collapse of the market. Then along came September 11 and everything was forced to change again. The Fed and other central banks as well unleashed more liquidity into the market coupled a with ratcheting down of interest rates to the point where they became negative (interest rates less than the rate of inflation) and they have remained there despite recent interest rate hikes. This has now unleashed a second bubble not only in stocks but as well in bonds and the housing market as the banking system further loosened the system with the low interest rates to provide seemingly a never ending stream of mortgage funds and lending knowing that the Fed will not raise interest rates to no further than a neutral level. At that level it still doesn't cause any serious pain and lenders (banks) still maintain huge lending spreads while paying little for their funds.
And the investment dealers, banks and hedge funds after smarting from the collapse of the tech market rebounded jumped into the fray with additional speculation not only in investment grade bonds but derivatives and junk bonds. Today junk bond yield spreads to US Treasuries are at record low levels despite a track record of knowing that after 3 years 50% of junk bonds are typically in default and after 11 years 80% of junk bonds are in default. Key of course is getting out at the right time. While the investment dealers, banks and hedge funds might they also ensure that the public will probably be left holding the bag as they chase yield.
Today others are wondering whether there is a bubble in commodity stocks (particularly oil) and here in Canada, Income Trusts. But commodities are driven by growing global demand and the income trusts while driven by yield many of the businesses are there because the income trust model suits them well and they have a long track record in the business.
One of the more dangerous bubbles is in the housing and property markets where low interest rates have encouraged record mortgage lending including refinancings and the subsequent cash has been poured into the purchase of consumer goods thus propping up the economy. Rising interest rates will cool the mortgage refinancing and with millions already refinanced demand will fall but rising interest rates on mortgages many of which were financed with floating rates will be pressed. Long after the purchase of that second or third SUV or 60 inch LCD Television wears off the mortgage remains and as demand falters for housing prices revert to a their long term mean.
While housing prices have shown no real tail off as of yet it is already on the downswing in places such as Great Britain where interest rates have risen faster. As well one only has to look at the rising stock of rental units coming on the market to realize that the housing and property bubble is getting near the end. In typical fashion it may end with a thud rather than any clear sign that a top is being made. A bust in the housing market will typically harm the most those centres where property and housing prices have been rising very quickly. Those areas are in large urban centres in the United States and Canada which of course contain the largest stock of housing.
But as another sign that the so called booming economy may not be what it is all cracked up to be we noted a report composed of data taken directly from the US Department of Labour, the US Department of Commerce, the Conference Board, the Congressional Budget Office, the Office of Management and Budget, and the Brookings Tax Policy Center. It is an interesting array of data.
During the period 2001-2005 (to February) the period of the George W. Bush Presidency the following has taken place:
- While non-farm payroll is up roughly 400 thousand jobs, private non-farm payroll employment has fallen 500 thousand jobs. Worse Manufacturing Employment has lost 2.8 million jobs for a net loss of 2.9 million jobs.
- The Bush Administration is the first US administration since Herbert Hoover to have a net job loss.
- The Unemployment rate rose from 4.2% in January 2001 to 5.4% in February 2005 and given the way unemployment is actually compiled it is suspected that the real unemployment rate may be 9% or higher.
- Long term unemployment as defined by people unemployed for more than 26 weeks has more than doubled since January 2001.
- It was estimated that between tax cuts and economic growth in February 2003 that upwards of 2 million jobs would be created by now. The reality was about 300 thousand jobs.
- During the period 1996-2000 real median weekly earnings of full-time workers averaged a 1.7% increase. Since 2001 it has averaged .2%.
- From 1950-2000 average US GDP growth was 3.3%. Since 2001 it has been 2.7%.
- Investment growth is the second lowest in 50 years only surpassing that under the administration of Gerald Ford.
- Business investment in plant and equipment has grown less than 4% since 2001 as many businesses have closed and reopened in low cost Asian countries.
- Consumer confidence despite improving of late still sits 10% lower than where it was in January 2001 (Conference Board).
- The stock market of course remains well down from its all time highs the first administration since Richard Nixon to have it happen and only the second since Herbert Hoover.
- Large projected budget surpluses that were estimated to be in the area of $397 billion annually by 2004 instead turned into a $412 billion deficit (Congressional Budget Office).
- In February 2001 the Bush administration (Office of Management and Budget) projected Public Debt would be $1.2 trillion by 2008; the current projection is $5.7 trillion.
- The Brookings Tax Policy Center has calculated that the tax cuts for people making one million or more is more than 90 times the cut for middle income homes.
- Household income has fallen 1.2% the greatest average decline in household income in any administration in over 40 years.
- Real Median Household Income has fallen $1535 since 2000 (average $44,853 down to $43,318) (US Department of Commerce).
- The poverty rate in the US has climbed the second highest average of any administration over the past 45 years (only exceeded by the administration of George H. W. Bush). (US Department of Commerce).
- 4.3 million more Americans are estimated to live in poverty since 2000 (US Department of Commerce).
- 5.2 million more Americans are without Health Insurance now totalling over 45 million (US Department of Commerce). Upwards of half of all bankruptcies are due to a health crisis.
Posing the question "Is America going broke?" is of course gratuitous. US debt still maintains an AAA rating as do many other highly industrialized countries such as Canada. That rating is of course based on unlimited taxing power. Of course they could also slash huge swaths of domestic support programs which is what has been proposed. That they are of course domestic support programs provides dislocations of a different sort. Boosted on the other side are Homeland Security and Defence.
Over the past five years total debt has grown by roughly $6.1 trillion or about 33%. This is against a backdrop of GDP growth of $1.9 trillion or 19%. Meanwhile Personal Income grew $1.2 trillion less than 15% while consumer debt grew $3.2 trillion up 46%. Debt is growing at a faster rate than income. In 2000 debt to disposable income was 98% and in 2004 it had increased to 120%. Numbers in Canada, Britain are not a whole lot different and indeed in Britain they are worse. While household assets prices have been increasing they are only 70% of disposable income. Debt is growing even faster. The housing boom over the past decade is growing at a faster rate then even in the late 1980's that ended in a huge housing and property collapse. Yet we are told there is no bubble.
While the bulls love to point out that things are a lot better than they were in October 2002 one has to put that in perspective. Looking at many of the numbers above one realizes that it is a world of illusion built on a bed of debt. US private sector real wages and salaries are up barely 2% from the trough back in 2002. The average of the last six recoveries was just over 10%. As our numbers indicated above wages are actually falling behind even as debt grows. Massive build ups in debt always end badly and over the past 5 years we have allowed debt to grow to enourmous levels. A booming economy? We think not. Someone is being primed to become roast pig.